Generac Holdings Inc. (NYSE:GNRC) Q3 2023 Earnings Call Transcript

Generac Holdings Inc. (NYSE:GNRC) Q3 2023 Earnings Call Transcript November 1, 2023

Generac Holdings Inc. beats earnings expectations. Reported EPS is $1.64, expectations were $1.51.

Operator: Good day and thank you for standing by. Welcome to the Third Quarter 2023 Generac Holdings Inc. Earnings Call. [Operator Instructions] Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, Kris Rosemann, Senior Manager, Corporate Development and Investor Relations. Please go ahead.

Kris Rosemann: Good morning and welcome to our third quarter 2023 earnings call. I’d like to thank everyone for joining us this morning. With me today is Aaron Jagdfeld, President and Chief Executive Officer; and York Ragen, Chief Financial Officer. We will begin our call today by commenting on forward-looking statements. Certain statements made during this presentation as well as other information provided from time-to-time by Generac or its employees may contain forward-looking statements and involve risks and uncertainties that could cause actual results to differ materially from those in these forward-looking statements. Please see our earnings release or SEC filings for a list of words or expressions that identify such statements and the associated risk factors.

A closeup of a technician controlling a power generation facility.

In addition, we will make reference to certain non-GAAP measures during today’s call. Additional information regarding these measures, including reconciliation to comparable U.S. GAAP measures, is available in our earnings release and SEC filings. I will now turn the call over to Aaron.

Aaron Jagdfeld: Thanks, Kris. Good morning, everyone and thank you for joining us today. Our third quarter results reflect improving operating performance led primarily by continued strength in C&I product shipments and sequential growth in home standby generator shipments. Year-over-year, overall net sales decreased 2% to $1.07 billion with core sales declining 4% during the quarter. Residential product sales decreased 15% as compared to the prior year, representing a significant improvement in sales decline from the prior two quarters as field inventory levels of home standby generators continued to decline during the quarter and portable generator sales decreased from a strong prior year comparison that included the impact of Hurricane Ian.

Global C&I product sales increased approximately 24% to an all-time quarterly record with growth across nearly all regions. We returned to year-over-year margin expansion for gross and adjusted EBITDA margins in the quarter, driven by lower input costs and continued production efficiencies. In addition, we generated significant free cash flow during the quarter, allowing us to complete approximately $100 million of share repurchases. Third quarter home standby shipments grew at a strong sequential rate, but declined on a year-over-year basis as we continued our efforts to reduce field inventory levels. Power outage activity in the U.S. was well above the long-term baseline average during the quarter despite not having the benefit of a major outage event, which we had experienced in the third quarter of each of the 3 previous years.

Against a strong comparable period, the higher outage activity combined with well-publicized grid stability issues drove home consultations in the quarter meaningfully higher from the prior year and marked the second highest quarter on record behind only the third quarter of 2021, which included the impact of Hurricane Ida and was only months after the Texas deep-freeze major event in February of 2021. Our residential dealer count was approximately 8,700 at the end of the quarter, an increase of 200 from the prior year and over 2,000 from pre-COVID levels. Additionally, we continue to make good progress in training non-dealer contractors as our initiatives to grow installation capacity maintained positive momentum in the third quarter. Activations which are a proxy for installations improved at a solid sequential rate in the quarter, but declined from a strong comparable period in 2022 that marked an all-time high for a third quarter.

Activations in the month of October continued this strong sequential improvement, providing further confidence that the home standby market has formed and is holding a new and higher baseline level of demand. The number of home standby generators in our distribution channels declined further in the quarter as we continue to make progress in reducing field inventories. As previously disclosed, certain regions and channels are at healthier levels of field inventory than others and field inventory levels of certain models are declining more quickly than others. Although we continue to undership end market demand during the third quarter, the gap between shipments and activations narrowed meaningfully as compared to the first half of the year. These factors, together with the continued strength in leading indicators of demand during the third quarter support our projection for home standby generator sales, returning to growth in the fourth quarter of 2023 while still working to reduce field inventory to more sustainable levels.

In addition to the positive near-term momentum that is building within the home standby market, we remain confident in the long-term outlook we shared at our recent Investor Day in September. The megatrends that are driving awareness for backup power remain as compelling as ever. As electrification trends drive demand forward and the adoption of intermittent renewable power generation accelerates, we expect that consumers will become even more reliant on an electrical grid that is increasingly susceptible to power outages caused by the combined threats of more severe and volatile weather and deteriorating supply-demand dynamics. We believe home standby generators will remain the most effective and economical solution for whole home resiliency for many years to come as homeowners look for peace of mind to address the impact of increasingly frequent and longer duration power outages.

In addition to the stronger-than-expected home standby shipments, our Residential Energy Technology Products and Solutions returned to year-over-year sales growth in the third quarter as continued strength in Ecobee sales more than offset weakness in shipments of our power cell energy storage systems as broader market conditions for residential solar and energy storage deteriorated further in the quarter. As a result of these softer end market conditions, we now expect full year 2023 gross sales for residential energy technology to be approximately 10% below our prior guidance of $300 million. Ecobee continues to take market share with strategic retail partners in the smart thermostat market and the team successfully launched our new smart doorbell camera in the month of October.

In addition to providing increased levels of homeowner engagement with our home energy management platform, the smart doorbell camera showcases Ecobee’s ability to drive innovation and differentiated product development. Ecobee’s strong product development capabilities, combined with their focus on creating an exceptional user experience are central to the continued build-out of our home energy ecosystem. Also during the third quarter, we announced the opening of a new engineering center of excellence in Reno, Nevada. This facility will house the development and testing of batteries, switches, power electronics and other clean energy solutions as we continue to invest in the R&D infrastructure and world-class talent that is required to develop and test the innovative residential energy technology solutions we are bringing to the market in the years ahead.

Additionally, our grid services team was awarded a $50 million grant from the Department of Energy in the month of October as part of the grid resilience and innovation partnerships program to pursue a project demonstrating the efficient building electrification can be achieved while minimizing system overload, reliability issues and the need for infrastructure upgrades. We’re proud to receive this validation of our vision to utilize multiple energy technologies to support homeowners while providing valuable products and services that benefit both the grid and homeowners. I now want to provide commentary on our C&I products, which continue to outperform our expectations in the quarter. Domestic C&I product sales grew at a robust rate compared to the prior year as strength in shipments to customers for beyond standby applications and industrial distributors more than offset weaknesses in the telecom channel during the quarter.

Shipments of natural gas generators used in applications beyond traditional emergency standby projects again grew at an exceptional rate during the third quarter. We believe we are in the very early innings of this compelling new market opportunity as ongoing grid stability concerns and volatile energy markets drive interest in these solutions. These emerging applications are just one of the many ways that we’re leveraging our position as the leading provider of natural gas generators to support increased adoption of energy technology solutions in C&I end markets. We also continue to build an increasingly comprehensive solution set to enable the deployment of our products in multi-asset applications, such as pairing our smart grid ready generators with our emerging C&I storage, connectivity, advanced controls and grid services platforms.

Shipments of C&I generators through our North American distributor channel also grew again at a strong rate. Quoting activity remained resilient in the quarter, growing on a year-over-year basis and supporting our expectations for continued growth in this important channel that serves a wide range of end markets. As previously disclosed, order patterns from rental companies have moderated after several quarters of exceptional performance. And third quarter sales to our national and independent rental equipment customers were approximately flat from the prior year. Despite the expected near-term softness, we continue to expect that this historically cyclical end market has a substantially long-term runway for growth given the critical need for future infrastructure-related projects that leverage our products sold to this channel.

As expected, sales to national telecom customers declined during the third quarter as compared to a strong prior year comparison. While we continue to expect shipment and order trends for these products to be softer in the coming quarters, we believe investment in telecom infrastructure remains a secular trend as global tower and network hub counts further expand and the increasingly critical nature of wireless communications requires backup power for resiliency. While we are seeing near-term softness in the telecom and rental channels as previously expected, the longer term growth opportunity for backup power and energy technology solutions in C&I end markets remain significant. To help serve the expected future demand growth, we recently announced an expansion project in Beaver Dam, Wisconsin, which is scheduled to be complete in early 2025, and will expand our manufacturing capabilities and capacity for a range of C&I stationary products for the North American market.

Total sales for our International segment increased 14% year-over-year during the third quarter with the combined impact of acquisitions and favorable foreign currency effects contributing approximately 11% sales growth. Core total sales growth was driven by strength in important long-term growth markets such as India, Latin America, Australia and the Middle East, partially offset by lower portable generator sales in Europe as energy security concerns in the region have moderated from peak levels seen in prior quarters. International growth remains an important strategic focus as we replicate the Generac playbook in a growing number of regions around the world. Geographic expansion, together with the increasing breadth of our product portfolio of backup power and energy technology solutions is expected to drive continued growth in the segment.

Power resiliency concerns related to increasingly severe and volatile weather and rising supply/demand imbalances are not unique to North America. And as the global energy transition accelerates amid rising geopolitical tensions, we will continue to support businesses and homeowners in solving for their energy resiliency needs. In closing this morning, our third quarter results and reiteration of our full year 2023 overall net sales and adjusted EBITDA guidance reflect improving operating performance and the hard work and strong execution by our teams. We believe we are moving closer to more sustainable levels of field inventory for home standby generators as we experienced positive momentum in key fundamental metrics during the third quarter, supporting our expectation for a return to year-over-year sales growth for these products in the fourth quarter and 2024.

These sales growth expectations, together with the return to margin expansion and robust free cash flow generation, validate our commitment to a long-term focus on executing our powering a Smarter World enterprise strategy. We will continue to invest for future growth and position Generac growing residential and C&I energy ecosystems to drive value for homes and businesses around the world as detailed at our Investor Day in September. The megatrends that support the longer term demand for growth profile for backup power and energy technology solutions remain firmly intact, and we maintain our conviction that Generac is uniquely positioned to lead the evolution to a more resilient, efficient and sustainable energy future. I’ll now turn the call over to York to provide further details on our third quarter results and our remaining outlook for the year.

York?

York Ragen: Thanks, Aaron. Looking at our third quarter 2023 results in more detail, overall net sales decreased 2% to $1.07 billion during the third quarter of 2023 as compared to $1.09 billion in the prior year third quarter. The combination of contributions from recent acquisitions and the favorable impact from foreign currency had an approximate 2% net favorable impact on revenue growth during the quarter. Briefly looking at consolidated net sales for the third quarter by product class, residential product sales declined 15% to $565 million as compared to $664 million in the prior year. As Aaron discussed in detail, lower shipments of home standby and portable generators drove this decline in residential product sales. To a lesser extent, shore and clean energy products also contributed to the year-over-year decline, partially offset by growth in Ecobee Smart Thermostat sales.

Commercial and industrial product sales for the third quarter of 2023 increased 24% to $385 million as compared to $311 million in the prior year quarter. Contributions from recent acquisitions and the favorable impact of foreign currency contributed approximately 5% revenue growth in the quarter. This strong core sales growth was driven by an increase in domestic shipments to industrial distributors and direct customers for beyond standby applications as well as a more modest growth in international shipments of C&I products. As expected, shipments to our telecom customers were down sharply compared to prior year. Net sales for other products and services increased 7% to $121 million as compared to $113 million in the third quarter of 2022.

Core sales growth of 6% was primarily due to growth in sales of parts and accessories, company-owned industrial distributor project and service revenue and energy technology grid services revenue. Gross profit margin was 35.1% compared to 33.2% in the prior year third quarter as a result of lower raw material and logistics costs, production efficiencies and marginally higher pricing compared to the prior year. This was partially offset by the impact of unfavorable sales mix, primarily driven by lower home standby shipments in the current year quarter. Operating expenses decreased $3 million or 1% as compared to the third quarter of 2022. As highlighted in our reconciliation schedules in the earnings release, the current year quarter included a $22 million provision for legal charges related to certain Ecobee patent litigation matters.

The prior year includes $55 million of charges comprised of $18 million of bad debt expense related to a clean energy product customer that filed for bankruptcy and a $37 million charge for clean energy product warranty-related matters. Excluding these items in the current and prior year, operating expenses increased by $31 million or 14%, primarily driven by increased employee and marketing costs in the current year period and a favorable contingent consideration adjustment in the prior year period. Adjusted EBITDA before deducting for non-controlling interest, as defined in our earnings release, was $189 million or 17.6% of net sales in the third quarter as compared to $184 million or 16.9% of net sales in the prior year. This improved EBITDA percent was primarily driven by higher gross margins as compared to the prior year, partially offset by an increase in operating expenses as we continue to invest for future growth.

I will now briefly discuss financial results for our two reporting segments. Domestic segment total sales, including intersegment sales, decreased 6% to $894 million in the quarter as compared to $947 million in the prior year, with minimal favorable impact from acquisitions. Adjusted EBITDA for the segment was $160 million, representing 17.9% of total sales as compared to $160 million in the prior year or 16.9% of total sales. International segment total sales, including intersegment sales, increased 14% to $208 million in the quarter as compared to $183 million in the prior year quarter. Core sales, which exclude the impact of acquisitions and currency, increased approximately 3% compared to the prior year. Adjusted EBITDA for the segment before deducting for non-controlling interest was $28 million or 13.6% of net sales as compared to $24 million or 13.2% of net sales in the prior year.

Now switching back to our financial performance for the third quarter of 2023 on a consolidated basis. As disclosed in our earnings release, GAAP net income for the company in the quarter was $60 million as compared to $58 million in the third quarter of 2022. In addition to the items just discussed, the current year net income includes approximately $9 million of additional interest expense compared to the prior year due to higher borrowings and interest rates. GAAP income taxes during the current year third quarter were $19 million or an effective tax rate of 24.3% as compared to $12 million or an effective tax rate of 16.1% for the prior year. The increase in the effective tax rate was primarily due to the prior year quarter, including certain favorable discrete tax items and a larger benefit from equity compensation as compared to the current year quarter.

Diluted net income per share for the company on a GAAP basis was $0.97 in the third quarter of 2023 compared to $0.83 in the prior year. The strong year-over-year increase in GAAP earnings per share relative to growth in GAAP net income was primarily driven by a lower share count in the current year period, coupled with the redeemable non-controlling interest redemption value adjustment that was recorded in the prior year period. See our earnings per share footnote for further information on our EPS calculations. Adjusted net income for the company, as defined in our earnings release, was $102 million in the current year quarter or $1.64 per share. This compares to adjusted net income of $112 million in the prior year or $1.75 per share. Cash flow from operations was $140 million as compared to minus $56 million in the prior year third quarter, and free cash flow, as defined in our earnings release, was $117 million as compared to minus $73 million in the same quarter last year.

The increase in free cash flow was primarily due to a significant use of cash for working capital in the prior year period that did not repeat in the current year quarter, partially offset by higher interest payments and capital expenditures. Total debt outstanding at the end of the quarter was $1.58 billion, resulting in a gross debt leverage ratio at the end of the third quarter of 2.6x on an as-reported basis. Additionally, during the third quarter, we repurchased approximately 876,000 shares of our common stock for $100 million. There is approximately $178 million remaining on our current share repurchase authorization as of the end of the third quarter. With that, I will now provide further comments on our remaining outlook for 2023. As disclosed in our press release this morning, we are maintaining our overall net sales outlook for the full year 2023.

We continue to expect overall net sales for the full year to decline between minus 10% to minus 12% as compared to the prior year, which includes approximately 2% net favorable impact from acquisitions and foreign currency. Looking at the product class mix, given the outperformance of C&I products and softness in shore and clean energy products during the third quarter, we now expect the mix of C&I product shipments for the full year to be approximately 100 basis points higher relative to our previous guidance, with the offset in residential product shipment mix. Our gross margin expectations for the full year 2023 are also unchanged as we still anticipate approximately 100 basis points of gross margin improvement over 2022 levels, driven primarily by favorable price cost benefits, partially offset by the unfavorable mix impact resulting from lower home standby generator sales for the full year.

Our adjusted EBITDA margins before deducting for non-controlling interests are still expected to be approximately 15.5% to 16.5% for the full year, implying that fourth quarter 2023 EBITDA margins would be over 20%, a significant improvement over prior year fourth quarter. We expect to generate strong operating free cash flow in the fourth quarter, resulting in an adjusted net income to free cash flow conversion at well over 100% for the full year as inventory levels are projected to further moderate. This return to robust free cash flow generation allows for continued capital allocation optionality as we move through the remainder of the year. We are also providing updated guidance details to assist with modeling adjusted EPS and free cash flow for the full year 2023.

Importantly, to arrive at appropriate estimates for adjusted net income and adjusted EPS, add-back items should be reflected net of tax using the expected effective tax rate. For 2023, our GAAP effective tax rate is still expected to be approximately 25%. Interest expense is now expected to be approximately $95 million compared to the prior guidance of approximately $92 million due to higher projected interest rates and borrowings. Our capital expenditures are still projected to be approximately 3% of our forecasted net sales for the year. Depreciation expense is still forecast to be approximately $62 million in 2023. GAAP intangible amortization expense is now expected to be approximately $104 million during the year as compared to the previous guidance of $102 million.

Stock compensation expense is still expected to be between $40 million to $43 million for the year. Given the share repurchases executed during the third quarter of 2023, our full year weighted average diluted share count is now expected to decrease to approximately 62.3 million shares. And finally, this 2023 outlook does not reflect potential additional acquisitions or share repurchases that could drive incremental shareholder value. This concludes our prepared remarks. At this time, we’d like to open up the call for questions.

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Q&A Session

Operator: [Operator Instructions] Our first question comes from the line of Tommy Moll with Stephens Inc. Your line is now open.

Tommy Moll: Good morning and thank you for taking my question.

Aaron Jagdfeld: Good morning, Tom.

Tommy Moll: Aaron, maybe no big surprise here, I wanted to start on your comments regarding the home standby field inventory. I think I heard you say that units were lower quarter-over-quarter. And so my related question was, can you give us an update on the times normal? I think last quarter, it was 1.2 to 1.3. Where do we sit today? And what additional commentary, can you give us, in particular, on the wholesale and retail channels? Thank you.

Aaron Jagdfeld: Yes. Thanks, Tom. Yes, we did say this morning that inventories continue – field inventories continue to come down. And the way we phrased it, they are reaching a more sustainable level because we’re definitely seeing areas as we noted, I think, not only at our Investor Day, but maybe even on the last call, where we have certain regions and certain models, certain channels like our dealer channel, in particular, that are or feeling like we’re kind of abnormal. And they are back to the whole question of what is normal, right? I mean we picked a pre-COVID kind of average to say what that is. And so we continue to work towards that and making good progress. We’re still undershipping the market in terms of overall end market demand.

So – but it’s narrowing up. It’s not nearly what it was earlier this year. We were severely under shipping the market earlier this year. That’s why the results were what they were. And as we get closer to kind of that, I would call it, in-line shipping to market end market demand, you’re seeing the impact of that on the results, both in the gross margin level as well as EBITDA margins. We’re able to really focus on improving the efficiency in our factories because we’re taking up our production rates to get closer to that end market demand. The really good news is we continue to see end market demand remain quite strong for home standby. And that’s in spite of having it’s really kind of a light season relative to the third quarter here.

outages in total were above average, the long-term average. And of course, there were a lot of well-publicized articles around potential outages with some of the demand – supply-demand challenges that remain out there. But we feel really good about where the category is at. And we feel like as we’ve been saying all along, as we finish up the year here and we get into 2024, we’re going to be much, much closer to normal at all channels. And so the other part of your question on wholesale and retail, as we’ve said in the past, if you look at all kind of the three major channels as we think about them dealer, wholesale and retail, dealer feels like it’s closer to normal. Wholesale would be next in line and then retail would be a little bit further out, but they are all approaching a more normal level.

Operator: [Operator Instructions] And your next question comes from the line of Michael Halloran with Baird. Your line is now open.

Aaron Jagdfeld: Hey, Mike. We need to come back to Mike.

York Ragen: Yes. Might have to come back to Mike.

Operator: [Operator Instructions] Your next question comes from the line of Jeff Hammond with KeyBanc Capital Markets. Your line is now open.

Aaron Jagdfeld: Jeff, are you there?

York Ragen: We try the next one.

Aaron Jagdfeld: We try the next one.

Operator: [Operator Instructions] Next question is from Christopher Glynn with Oppenheimer. Your line is now open.

Christopher Glynn: Hey, thanks. Good morning, guys. Can you hear me?

Aaron Jagdfeld: Yes, we can hear you, Chris. Loud and clear.

Christopher Glynn: Right. So I was just curious about dealer and close rate productivity. I know you’re doing a lot with dealers. You had a bit of an explosion during the pandemic, a little bit of a lack of training that you’re catching up on. So just curious how that productivity selling commercial is playing out and what percent of HSB sales go through the dealer channel, where I think you said the inventories are now about normal in fact.

Aaron Jagdfeld: Yes. Thanks, Chris. So the majority of the sales, as we say, more than 50% go through that dealer channel. It’s a really important channel for us. Our wholesale and retail channels are important channels as well, but the dealer channel with 8,700 dealers is clearly a critical area of focus for us. And of course, the bandwidth in that dealer channel around sales and installation and service as the market grows, we’ve got over 3 million units in the field. That’s a really important area. As far as close rates, and that is the channel that we can measure close rates on because we have our PowerPlay sales system is offered through that channel. So it’s a way for them to quote and sell product. And so we get really good visibility into close rates by dealer, by product, by region.

And as we said on the last call, close rates have kind of flattened out, and that’s how they have kind of played out similar to that. Actually, I mean, we’ve seen some near-term improvement here, but we’re not ready to call it a new trend up, but the month of October has been relatively good. It’s – you have to think of it in the context, this is a look back, right? So when we talk about close rates, we have a window of time, we look back because it takes time for quotes to mature to a point of – for us to make a call on whether it’s closed as a sale or not. But we are seeing some green shoots there, but we – we’re not ready to quite call it a trend yet. So we’ve still kind of forecasted things here as being somewhat flat.

The consumer, obviously, as everybody is well aware, there is some uncertainty out there looming around the consumer in certain big ticket discretionary purchase categories. But as we’ve said, in our category, in particular, outages tend to help us overcome any general macro weakness in the consumer. And that has been the historical case for us. And I think that might be why we saw what we saw in the third quarter is outages were above the long-term average. And so we’ve seen the consumer perform quite well in our category of products. But we’re keeping a very close eye on it. We want to see how things play out here for the balance of the year and into 2024. But we’re encouraged by sales leads for sure. I mean October was another strong – the third quarter was another strong quarter for us, second best quarter ever for us in terms of just sales leads.

And so that’s been really encouraging to see in terms of just the interest – the overall interest and awareness in the category.

Christopher Glynn: Close rates maintaining.

Aaron Jagdfeld: Yes.

Operator: [Operator Instructions] Your next question comes from Michael Halloran with Baird. Your line is now open.

Aaron Jagdfeld: I have to come back to Mike again.

York Ragen: Yes.

Operator: [Operator Instructions] Next question is from Jeff Hammond with KeyBanc Capital Markets. Your line is now open.

Aaron Jagdfeld: Yes, hope for two.